Completion Instructions Return of Capital Adequacy Ratio Part IIIb

63 Pages·2007·0.31 MB·English

Completion Instructions

Return of Capital Adequacy Ratio
Part IIIb – Risk-weighted Amount for Credit Risk
Standardized (Credit Risk) Approach
Form MA(BS)3(IIIb)

Introduction

1. Form MA(BS)3(IIIb) of Part III should be completed by each authorized
institution incorporated in Hong Kong using the standardized (credit risk)
approach (STC approach) to calculate credit risk under Part 4 of the Banking
(Capital) Rules.

2. This Form covers the following exposures of the reporting institution:

(a) All on-balance sheet exposures and off-balance sheet exposures booked in
its banking book, except:

(i) exposures subject to deduction from the core capital and/or
supplementary capital (which should be reported in Form
MA(BS)3(II)); and

(ii) exposures subject to the requirements of Part 7 of the Rules (which
should be reported in Form MA(BS)3(IIId));

(b) All exposures to counterparties under the following transactions booked in
its trading book: repo-style transactions treated as collateralized lending
(see paragraph 9 below), OTC derivative transactions and credit derivative
contracts.

(c) All exposures which are exempted from the requirements of Part 8 of the
Rules but expose the institution to credit risk.

3. This Form and its completion instructions should be read in conjunction with the
Rules and the relevant supervisory policy/guidance on the revised capital
adequacy framework.

Section A: Definitions and Clarification

4. The amounts reported in the column of “Principal Amount” should be net of
specific provisions for all items in Division A and items 1 to 9c of Division B,
but gross of specific provisions for items 10a to 16 in Division B. For items
10a to 16 in Division B, specific provisions should be deducted from the credit
equivalent amount and the resulting figure should be reported in the column of
“Credit Equivalent Amount”.

MA(BS)3(IIIb)/P.1 (3/2007)
5. “Principal Amount after CRM” means the reported “Principal Amount” adjusted
for the capital effect of recognized credit risk mitigation (CRM). The latter
refers to techniques the reporting institution may use to mitigate credit risk,
hence reduce the capital requirement of a credit exposure. Four types of CRM
techniques, viz., collateral, netting, guarantees and credit derivatives, are
recognized for this purpose provided that they satisfy the relevant operational
requirements and conditions set out in the definition of “valid bilateral netting
agreement” in section 2(1), or sections 77, 79, 80, 98 or 99 of the Rules, as the
case requires. For the avoidance of doubt, guarantees issued by other offices of
the reporting institution are not regarded as recognized CRM. See Section C for
capital treatment and reporting arrangement.

6. Double counting of exposures arising from the same contract or transaction
should be avoided. For example, only the undrawn portion of a loan
commitment should be reported as an off-balance sheet exposure under item 9a,
b or c of Division B while the actual amount which has been lent out should be
reported as an on-balance sheet exposure under the relevant class of Division A.
Trade-related contingencies such as trust receipts and shipping guarantees for
which the exposures have already been reported as letters of credit issued or
loans against import bills etc. should not be reported under item 3 of Division B.

7. In certain cases, credit exposures arising from derivative contracts may already
be reflected, in part, on the balance sheet. For example, the reporting institution
may have recorded current credit exposures to counterparties (i.e. mark-to-
market values) under foreign exchange and interest rate related contracts on the
balance sheet, typically as either sundry debtors or sundry creditors. To avoid
double counting, such exposures should be excluded from the on-balance sheet
exposures and treated as off-balance sheet exposures for the purposes of this
Form.

8. Accruals on an exposure should be classified and weighted in the same way as
the exposure. Accruals which cannot be so classified should, with the prior
consent of the Monetary Authority (MA), be included in Class XI - Other
exposures which are not past due exposures.

9. Other than those covered by valid bilateral netting agreements, the reporting
institution should adopt the “economic substance” approach for capital treatment
of repo-style transactions and report them as on-balance sheet exposures in
Division A in the following manner:

(a) repos of securities - where the reporting institution has sold securities under
repo agreements, the securities sold should continue to be treated as assets
on the balance sheet of the institution, with regulatory capital provided for
the credit exposure to the securities;

(b) reverse repos of securities - where the reporting institution has acquired
securities under reverse repo agreements, the transaction should be treated
as a collateralized lending to the counterparty, providing the securities
acquired meet the relevant criteria for qualifying as recognized CRM under
the Rules. Regulatory capital should then be provided for the credit
MA(BS)3(IIIb)/P.2 (3/2007)
exposure to the counterparty, taking into account the CRM effect of the
collateral;

(c) securities lending - the treatment is similar to that of repo transactions. The
securities lent should continue to remain as assets on the balance sheet of
the reporting institution, with regulatory capital provided for the credit
exposure to the securities; and

(d) securities borrowing - the treatment depends on whether the collateral
provided is cash or securities:

(i) Where the collateral provided is cash, the transaction should be treated
as a collateralized lending to the counterparty1, providing the securities
received meet the relevant criteria for qualifying as recognized CRM
under the Rules. Regulatory capital should then be provided for the
credit exposure to the counterparty, taking into account the CRM effect
of the collateral;

(ii) Where the collateral provided is not cash but securities, the securities
should continue to remain as assets on the balance sheet of the reporting
institution, with regulatory capital provided for the credit exposure to
the securities.

For repo-style transactions covered by valid bilateral netting agreements, the
reporting institution should refer to paragraph 26 of Section C for capital
treatment and reporting arrangement.

10. Underlying exposures of a synthetic securitization transaction which fulfils the
requirements set out in Schedule 10 of the Rules should be reported in this Form
with the CRM available to hedge the credit risk of the underlying exposures
taken into account. For cases which are not specified in these instructions or in
any other supervisory guidance relevant to securitization transactions, reporting
institution should consult the HKMA on the reporting arrangements.

Section B: Exposure Classification, Determination of Credit Conversion Factors
and Risk-weights

B.1 On-balance Sheet Exposures

Exposure Classification

11. Division A of the Form is organized according to the 12 standard classes into
which on-balance sheet exposures should be classified under the STC approach:

Class I - Sovereign exposures

1 For securities lending or borrowing where the contractual agreement is made between the securities
borrower/lender and the custodian (e.g. Clearstream Banking or Euroclear Bank) and the securities
borrower/lender has no knowledge as from/to whom the security is borrowed/lent, the custodian becomes
the “counterparty” of the securities borrower/lender.
MA(BS)3(IIIb)/P.3 (3/2007)
Class II - Public sector entity exposures
Class III - Multilateral development bank exposures
Class IV - Bank exposures
Class V - Securities firm exposures
Class VI - Corporate exposures
Class VII - Collective investment scheme exposures
Class VIII - Cash items
Class IX - Regulatory retail exposures
Class X - Residential mortgage loans
Class XI - Other exposures which are not past due exposures
Class XII - Past due exposures

12. The 12 classes are mutually exclusive and therefore any given exposure should
be reported under only one of them. For instance, any exposure which falls
within the definition of “past due exposure” should only be reported under Class
XII and not elsewhere.

Determination of Risk-weights

13. The risk-weight for an exposure under any of Classes I, II, IV to VII is
determined based on its credit assessment rating assigned by an external credit
assessment institution (ECAI) recognized by the HKMA. Each of these six
ECAI ratings based portfolios has its own risk-weighting framework under
which risk-weights are mapped to a scale of Credit Quality Grades represented
by the numerals 1, 2, 3, 4, 5 or 6, as the case may be. Annex IIIb-A sets out
how, for each portfolio, different sets of notations used by different ECAIs are
mapped to the Credit Quality Grades. It also provides separate scales
specifically for risk-weighting exposures to banks, securities firms and
corporates with short-term credit assessment rating assigned by ECAIs.

14. There are a number of general principles that AIs should follow for the selection
of the appropriate external credit assessment rating for risk-weighting an
exposure. These principles are incorporated in Annex IIIb-B.

15. The term “issuer rating” means, for all ECAI ratings based portfolios, an ECAI
issuer rating assigned to an obligor and the term “issue specific rating” means:

(a) for Class I (i.e. Sovereign Exposures): a long-term ECAI issue specific
rating specifically assigned to a particular debt obligation of an obligor;

(b) for Classes IV, V and VI (i.e. Bank, Securities Firm and Corporate
Exposures): either a long-term or a short-term ECAI issue specific rating
specifically assigned to a particular debt obligation of an obligor; and

(c) for Class VII (i.e. Collective Investment Scheme Exposures): an ECAI issue
specific rating specifically assigned to a particular collective investment
scheme.

MA(BS)3(IIIb)/P.4 (3/2007)
16. The following explains how exposures in each class are risk-weighted and,
where applicable, the relevant principles for reporting exposures under the class.

Item Nature of item

Class I Sovereign Exposures

1. Domestic currency exposures to the Government are risk-
weighted at 0%. Included are:

(a) deposits placed with and loans made to the Government
(these include those for the account of the Exchange Fund
and clearing balances with the Exchange Fund).

(b) holdings of Exchange Bills/Notes. Market makers who
have short positions in Exchange Fund Bills/Notes may
report their net holdings of such instruments provided the
short positions are covered by the Sale and Repurchase
Agreements with the HKMA. The following steps should
be taken in determining the amount to be reported:

(i) the long and short positions of instruments with a
residual maturity of under 1 year may be offset with
each other;

(ii) the long and short positions of instruments with a
residual maturity of 1 year and over may be offset with
each other;

(iii) if the net positions of both (i) and (ii) above are long,
the positions should be reported;

(iv) if the net position in (i) is long and the net position in
(ii) is short, or the other way round, the positions can be
netted with each other on a dollar for dollar basis. The
resultant net long position, if any, should be reported.

2. Other exposures to sovereigns include foreign currency exposures
to the Government, and all exposures to other sovereigns. For
risk-weighting purposes, these exposures should be divided into
those with an issue specific rating and those without.

(a) Exposure with an issue specific rating (i.e. rated exposure)

The issue specific rating should be used to determine the
applicable risk-weight of the exposure based on Table 1.

MA(BS)3(IIIb)/P.5 (3/2007)
Table 1
Credit Quality 1 2 3 4 5 6
Grade of an
issuer/issue
Risk-weight 0% 20% 50% 100% 100% 150%

(b) Exposure without an issue specific rating (i.e. unrated
exposure)

(i) Where the sovereign has no issuer rating and none of
its other debt obligations has an issue specific rating, a
100% risk-weight should be allocated to the exposure.

(ii) Where the sovereign has an issuer rating and/or any of
its other debt obligations has an issue specific rating,
the following instructions apply:

(A) Where the sovereign has an issuer rating, the risk-
weight which is applicable to that rating based on
Table 1 should be allocated to the exposure.
Nevertheless, in case the applicable risk-weight is
lower than 100%, the exposure should be senior
(i.e. unsubordinated) in order for the lower risk-
weight to apply.

(B) Where any of the other debt obligations of the
sovereign has an issue specific rating, the risk-
weight which is applicable to that rating based on
Table 1 should be allocated to the exposure.
Nevertheless, in case the applicable risk-weight is
lower than 100%, the exposure should rank pari
passu or senior to the rated debt obligation in all
respects in order for the lower risk-weight to apply.

(C) Where both (A) and (B) above apply, the reporting
institution will have the discretion to choose which
one to allocate to the exposure.

(c) Despite (a) and (b) above:

(i) where an overseas banking supervisory authority
exercises its discretion under Basel II to permit banks
in its jurisdiction to allocate a lower risk-weight to
domestic currency exposures to its sovereign, the
reporting institution may allocate the same lower risk-
weight to its domestic currency exposure to the
sovereign;

(ii) where (i) above is not applicable (e.g. the banking
supervisory authority concerned has not yet adopted
Basel II, or has adopted Basel II but has not exercised
MA(BS)3(IIIb)/P.6 (3/2007)
its discretion referred to in (i)), the institution may
allocate to its domestic currency exposure to a
sovereign a risk-weight of

(A) 0% if the exposure arises from a loan granted by
the institution to the sovereign;

(B) 10% if the exposure arises from fixed rate debt
securities with a residual maturity of less than one
year or floating rate debt securities of any maturity;

(C) 20% if the exposure arises from fixed rate debt
securities with a residual maturity of not less than
one year.

3. Relevant international organization exposures are risk-weighted
at 0%.

Class II Public Sector Entity (PSE) Exposures

4. Exposures to domestic PSEs should be allocated a risk-weight
which is the next higher risk-weight than the risk-weight
attributable to the credit quality grade applicable to the issuer
rating of the Government, with the following exceptions should
any of these become applicable in future:

(a) Where the issuer rating of the Government is mapped to
credit quality grade 4 or 5 (i.e. allocated a 100% risk-
weight), exposures to domestic PSEs should be allocated a
100% risk-weight.

(b) Where the issuer rating of the Government is mapped to
credit quality grade 6 (i.e. allocated a 150% risk-weight),
exposures to domestic PSEs should be allocated a 150%
risk-weight.

(c) If no issuer rating is assigned to the Government, exposures
to domestic PSEs should be allocated a 100% risk-weight.

5. Exposures to foreign PSEs should be allocated a risk-weight
which is the next higher risk-weight than the risk-weight
attributable to the credit quality grade applicable to the issuer
rating of the sovereign of the jurisdiction in which the PSEs are
incorporated, with the following exceptions:

(a) Exposures to sovereign foreign PSEs should be allocated
the risk-weight applicable to the issuer rating of the
sovereign of the jurisdiction in which the PSEs are
incorporated.
MA(BS)3(IIIb)/P.7 (3/2007)
(b) Where the issuer rating of the sovereign of the jurisdiction
in which a PSE is incorporated is mapped to credit quality
grade 4 or 5 (i.e. allocated a 100% risk-weight), exposures
to the PSE should be allocated a 100% risk-weight.

(c) Where the issuer rating of the sovereign of the jurisdiction
in which a PSE is incorporated is mapped to credit quality
grade 6 (i.e. allocated a 150% risk-weight), exposures to the
PSE should be allocated a 150% risk-weight.

(d) If no issuer rating is assigned to a sovereign, exposures to
its PSEs should be risk-weighted at 100%.

Class III Multilateral Development Bank (MDB) Exposures

6. MDB exposures are risk-weighted at 0%.

Class IV Bank Exposures

7a & b. Bank exposures should be divided into those with an original
contractual period of time for full repayment (“original maturity”)
of 3 months or less (“3 months’ exposures”) and those with an
original maturity longer than 3 months (“general exposures”).

Exposures within each of the two categories should then be
divided into those with an issue specific rating and those without.

(a) Exposure with an issue specific rating (i.e. rated exposure)

The issue specific rating should be used to determine the
applicable risk-weight of the exposure based on Table 2 if it
is a long-term issue specific rating, or based on Table 3 if it
is a short-term issue specific rating.

Table 2
Credit Quality Grade 1 2 3 4 5
of an issuer/issue
Risk-weight for 20% 50% 50% 100% 150%
general exposures
Risk-weight for 3 20% 20% 20% 50% 150%
months’ exposures
(other than those
which have a short-
term issue specific
rating)

MA(BS)3(IIIb)/P.8 (3/2007)
Table 3
Short-term Credit 1 2 3 4
Quality Grade of an issue
Risk-weight for exposures 20% 50% 100% 150%
with a short-term issue
specific rating

Notwithstanding the above, a rated 3 months’ exposure
denominated and funded in Hong Kong dollars may be
allocated a risk-weight of 20%.

(b) Exposure without an issue specific rating (i.e. unrated
exposure)

(i) Where the bank has no issuer rating and none of its
other debt obligations has been assigned an issue
specific rating, the risk-weight to be allocated should be
50% for a general exposure and 20% for a 3 months’
exposure. However, the risk-weight to be allocated
will be –

(A) the one applicable to the sovereign of
incorporation of the bank instead if it is higher
than either 50% or 20%, as the case may be; or

(B) 100% if the sovereign does not have an issuer
rating.

(ii) Where the bank has an issuer rating and/or any of its
other debt obligations has an issue specific rating, the
risk-weight of the exposure should be determined as
follows:

(A) Unrated general exposure

(I) Where the bank has an issuer rating and/or
any of its other debt obligations has a long-
term issue specific rating, the reporting
institution may, at its choice, determine the
risk-weight to be allocated to the exposure
according to either approach set out below:

(cid:1) Where the bank has an issuer rating, the
risk-weight which is applicable to that
rating based on the row of “Risk-weight
for general exposures” in Table 2 should
be applied to the exposure. Nevertheless,
in case the applicable risk-weight is lower
than 50%, the exposure should be senior
(i.e. unsubordinated) for the lower risk-
weight to apply;
MA(BS)3(IIIb)/P.9 (3/2007)
(cid:1) Where any of the other debt obligations of
the bank has a long-term issue specific
rating, the risk-weight which is applicable
to that rating based on the row of “Risk-
weight for general exposures” in Table 2
should be applied to the exposure.
Nevertheless, in case the applicable risk-
weight is lower than the 50%, the
exposure should rank pari passu or senior
to the rated debt obligation in all respects
for the lower risk-weight to apply.

(II) Where any of the other debt obligations of the
bank has a short-term issue specific rating, but
the bank does not have an issuer rating, and
none of its other debt obligations has a long-
term issue specific rating, the risk-weight
applicable to the exposure should be
determined according to (i) above.

(B) Unrated 3 months’ exposures

(I) Where none of the other debt obligations of
the bank has a short-term issue specific rating,
but the bank has an issuer rating and/or any of
its other debt obligations has a long-term issue
specific rating, the risk-weight which should
be applied to the exposure will be, at the
choice of the reporting institution, either:

(cid:1) the risk-weight applicable to the issuer
rating of the bank as determined based on
the row of “Risk-weight for 3 months’
exposures” in Table 2; or

(cid:1) the risk-weight applicable to the long-
term issue specific rating of any of its
other debt obligations as determined
based on the row of “Risk-weight for 3
months’ exposures” in Table 2.

(II) Where any of the other debt obligations of the
bank has a short-term issue specific rating, but
the bank does not have an issuer rating, and
none of its other debt obligations has a long-
term issue specific rating, the risk-weight
which should be applied to the exposure will
be the higher of:

MA(BS)3(IIIb)/P.10 (3/2007)